-LRB- Mental Floss -RRB- -- Investigators are trying to figure out whether the financial fraud allegedly perpetrated by Bernard L. Madoff was , in fact , the largest Ponzi scheme in history . The alleged scam , which cost investors $ 50 billion , sounds like a classic Ponzi racket .

The New York home of Bernard Madoff , who 's accused in a $ 50 billion Ponzi scheme .

But what is a Ponzi scheme ? And why does it bear this name ? First , you need to know a little bit about its namesake , Charles Ponzi .

Anyone can work a simple swindle , but you have to be a special kind of con man to have your name become synonymous with `` fraud . '' Ponzi pulled it off , though . After arriving in the U.S. from Italy in 1903 , Ponzi knocked around in a variety of unskilled jobs that usually ended when he got into trouble for theft or cheating customers .

A few years later , he moved to Canada , where he spent a hitch in prison for passing a forged check . When he eventually drifted back down to the U.S. , he needed a way to make some quick cash . Watch how a Ponzi scheme works ''

Making money via mail

Ponzi eventually found his way to get rich quick using a vagary of the postal system . At the time , it was common for letters abroad to include an international reply coupon -- a voucher that could be exchanged for minimum postage back to the country from which the letter was sent .

Thus , if you sent your buddy in France a letter , you could include a coupon so he could respond . -LRB- This practice still exists but is less common . -RRB- As exchange and postal rates fluctuated , though , there was an opportunity to make a profit . You only had to purchase postal reply coupons cheaply in some foreign country , send them back to the U.S. to swap them out for American stamps of a higher value , then sell these stamps .

This arrangement was perfectly legal ; it was just cleverly gaming the system . Ponzi started buying and selling postal reply coupons using agents in his native Italy , and he was making a good living doing it .

Unfortunately , whatever defect made Ponzi steal from his employers and pass bad checks prompted him to get greedy here , too . He started to recruit investors into his system with the promise of 50 percent returns in just a few days . Investors would pay their cash in , and sure enough , Ponzi would get them the promised return .

Everyone was happy with the results , and word started to spread about this Italian financial wizard . Within two years , he had employees all over the country recruiting new takers for this foolproof investment strategy .

Ponzi was pocketing millions , and he enjoyed a sumptuous life outside of Boston . At his peak , Ponzi was raking in $ 250,000 a day , which enabled him to collect such necessities as gold-handled canes . He became a celebrity investor , almost like the Warren Buffett of his day .

The scheme

Why is it hard to think of Ponzi 's name without affixing `` scheme '' to the end of it , then ? Ponzi 's underlying `` business '' -- the arbitrage on the postal coupons -- was n't actually as sound as he claimed . In fact , there was n't even really a business .

However , since so much money was flowing in from new investors , he could just pay off the returns for the old ones from the new cash . In fact , Ponzi did n't even need to pay off the old investors , since many of them wanted to reinvest their returns in this wonderful business . Ponzi 's charms made it easy for him to placate any worried customers , and his con looked unstoppable . Mental Floss : 4 very big paychecks for very little work

Fuzzy math

Eventually , though , smarter financial heads started looking at Ponzi 's business . Clarence Barron , owner of the Wall Street Journal and founder of the financial magazine that bears his name , realized Ponzi must have been a huckster and went on the offensive .

While Barron conceded that there probably was a way for a person to make a small amount of quick cash on the postal reply coupon scheme , he figured that Ponzi would have to be moving 160 million coupons around to raise the cash he needed to support the business . Since there were only 27,000 postal reply coupons circulating in the world , Ponzi 's story did n't check out . -LRB- Things only got worse when the Postal Service reported that there was n't a huge flow of the coupons from one country to the other . -RRB-

On top of that , Barron noted that Ponzi told newspapers he invested his own cash in real estate , stocks , and bonds like any normal investor . Barron pointed out the obvious question here : if Ponzi had this failsafe scheme in which he could make a 50 percent profit , why was he putting his own money into plain old investment instruments that would give him -LRB- maybe -RRB- a 5 percent return ? Those certainly did n't sound like the actions of a financial genius .

Barron 's conclusions ran as front-page news in the Boston Post in July 1920 , which would have been damning for most cons . Ponzi was such a charismatic force of nature , though , that many people chose not to believe the paper 's report . Few believed that their hero , the man who had `` tripled '' their life savings , was anything less than 100 percent legitimate .

In fact , the morning that the Post ran Barron 's report , investors lined up around the block outside of his office in an attempt to give him more money -- even after they 'd been told that they 'd been scammed . Ponzi later boasted that he 'd taken in a million dollars in new investments the day the report ran . Mental Floss : 5 of history 's worst perpetrators of corruption

The unraveling

Things were starting to look less rosy for the scammer , though . Although he 'd largely placated his investors after Barron 's report , Ponzi must have realized his window of opportunity was closing . He hired a publicist , William McMasters , but the PR man saw through Ponzi 's lies and renounced his client in the press . James Walsh reprints part of McMasters ' slam of Ponzi in his book , `` You Ca n't Cheat An Honest Man . ''

Of Ponzi , McMasters said , `` The man is a financial idiot . He can hardly add ... He sits with his feet on the desk smoking expensive cigars in a diamond holder and talking complete gibberish about postal coupons . ''

The next month , regulators raided Ponzi 's office and discovered that he did n't have a huge quantity of postal reply coupons . Since Ponzi had used the mail to notify his marks of how their `` investments '' were performing , he faced serious mail fraud charges ; in total , the government brought 86 charges against him in two separate indictments . Ponzi pled guilty to one of these charges in exchange for a light sentence of five years .

He served around three and a half years , then got his release to face state charges , for which he received a sentence of nine more years . But before he could go back to jail , he jumped bail and tried to start new scams in Florida and Texas . -LRB- You 'd think the government would have learned their lesson about trusting this guy . -RRB- Eventually , though , his time on the lam ran out , and he served his whole sentence .

Upon his release , Ponzi was deported to Italy and spent the rest of his life in poverty before dying in 1949 in Rio de Janeiro , where he 's buried in a pauper 's grave . Mental Floss : 10 things your body can do after you die

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Charles Ponzi was a real person who swindled investors in a postal scam

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Ponzi pocketed millions and enjoyed life but a publisher was suspicious

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Wall Street Journal 's Clarence Barron printed front page story slamming Ponzi

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Ponzi served time , was deported and died in 1949 -- buried in a pauper 's grave